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Wal-Mart Stores, the leading private employer in the world, operates in 25 countries with a strong presence in Mexico. Roughly about 20% of Wal-Mart’s 11,500 locations are based in Mexico. Over the last three years, the Justice Department has been investigating allegations that Wal-Mart paid bribes in Mexico to obtain permits.

A group of beneficial Wal-Mart owners filed a complaint with the Securities and Exchange Commission (SEC) and the Public Company Accounting Oversight Board (PCAOB) that Wal-Mart’s auditor, Ernst & Young (E&Y) was aware of the bribery long before the company disclosed this irregularity to U.S. authorities in 2011. According to the complaint letter, E&Y as the independent auditor should have reported the suspected bribery to the SEC as soon as it became aware of such improprieties in 2006.

Bribery Act

The Foreign Corrupt Practices Act of 1977 (FCPA) makes it unlawful for persons and entities to make payments to foreign government officials to assist in obtaining or retaining business. The Act was amended in 1998. The anti-bribery provisions of the FCPA now applies to foreign firms and makes it illegal for foreign companies to pay bribes in the U.S.

The Act levies criminal and civil liability for paying bribes to foreign government officials. The Justice Department has jurisdiction over the FCPA.

Investigations

The Justice Department launched an investigation following a 2012 New York Times article about the alleged Mexican bribes. According to the article, Wal-Mart Mexico unit paid middlemen to obtain permits and that Wal-Mart executives chose not to pursue an internal inquiry into the suspicious payments.

Although the three-year investigation remains incomplete, according to Wall Street Journal, the case could be resolved with a fine and no criminal charges against Wal-Mart executives because the charges may not be as severe as previously anticipated.

Auditor’s Obligations

According to the auditing standards (AU section 317), auditors have a responsibility to design procedures that provide reasonable assurance of detecting illegal acts. In cases of bribery, the auditor is also implicated because bribing a foreign government official is illegal in the US and also because any bribery is likely to have a material effect on a company’s financial statements.

Companies that pay bribes generally record the underlying transactions in their accounting books as legitimate operating expenses to avoid detection. Since bribes often involve disbursements of cash, recording a bribe as a legitimate operating expense results in false reporting of expenses on the income statement.

What are the duties of the external auditor when it becomes aware that its client is suspected of violating FCPA provisions?

The answer may surprise you.

If an outside auditor discovers an illegal act, it is required to notify responsible authorities within the company including the company’s board and audit committee.

The external auditor is not required to notify the government.

Only when the company refuses to take corrective actions or the company’s books are compromised is the auditor obligated to notify the government.

Essentially, the rules and obligations are suggesting that the company has the obligation to correct improper acts and also inform appropriate government authorities.

Top Gun: Tom (Cruise) Ray

According to Chief Tom Ray, past Chief Auditor of PCAOB and my colleague at Baruch College, external auditors are not legally obliged to inform outside regulators about potential scandals except in limited circumstances. Auditors are required to report those acts to management and the board’s audit committee, which is responsible for monitoring financial reporting and disclosure practices. The accounting firm also needs to evaluate whether the bribers would have a material impact on financial statements.

Top gun in auditing, Tom states that only when the company doesn’t take appropriate actions, an outside accounting firm may be legally required to report the problem to a federal agency,

Solipsism

Needless to say, Wal-Mart will become target of lawsuits. E&Y, with its deep pockets, is also likely to become a prime target. However, if the norm is to pay bribes to secure contracts, especially in developing and emerging countries, U.S. companies are at a disadvantage relative to almost all other countries that do not have anti-bribery provisions.